At the time in England, Keynes was credited by the academic community as the author of many serious books on economics. His essay “the end of Laissez-Faire”, (1926), presented his argument for active government intervention in economic affairs. Keynes was heralded as the “saviour of capitalism” amongst his colleagues rather than being recognised as the advocate of inflation that he was. Hayek disagreed immensely with the theories that Keynes held and the Hayek-Keynes debate became the most fundamental debate in monetary economics in the 20th century. Hayek felt that the problem with Keynes economics was his failure to understand the role that interest rates and capital structure play in a market economy. Hayek felt that Keynes had failed to address these issues adequately in his book “A Treatise on Money”, (1930). Hayek pointed out that “Keynes’s aggregation tended to redirect the analytical focus of the economist away from examining how the industrial structure of the economy emerged from the economic choices of individuals.” Keynes did not take kindly to Hayek’s criticism. He and Sraffa joined forces and attacked Hayek’s “Price and Production”, in an attempt to bury both Hayek and his cycle theory. Keynes then claimed he no longer believed what he had written in “A Treatise on Money”, and turned his attention to writing another book, “The General Theory of Employment, Interest and Money”, (1936), which in time became the most influential book on economic policy in the 20th century. The publication of this book totally altered the terms of the debate. Hayek then turned his attention to refining capital theory rather than criticising what Keynes had presented in his general theory. “Hayek was convinced that the essential point to convey to Keynes and the rest of the economic profession concerning monetary policy lay in capital theory. Thus Hayek proceeded to set forth his thesis in The Pure Theory of Capital (1941).” In this publication he further explained the origin of the business cycle in terms of central bank credit expansion and its transmission over time in terms of capital misallocation caused by artificially low interest rates. The book also attempted to develop a joint theory of investment and capital. However correct his assessment may have been, this book, Hayek’s most technical, was his least influential. The book inexplicably failed to sell. At this time Keynes’s brand on economics was on the rise. It appeared that in the eyes of the public Keynes had defeated Hayek and Hayek lost his standing in the profession. The “Pure Theory of Capital” proved to be Hayek’s last substantial effort in the area of theoretical neoclassical economics.
During this time Hayek was also involved in another grand debate sparked from Mises’ denial that “a socialist economy could price its goods and services in accordance with the principles of relative scarcity.” (Blaug, 1988, p88). This debate was known as the socialist calculation debate. Mises wrote, in his famous article “Economic Calculation in the socialist Commonwealth” (1920), that “pricing systems in socialist economies were necessarily deficient because if government owned the means of production, then no prices could be obtained for capital goods as they were merely internal transfers of goods in a socialist system and not objects of exchange, unlike final goods and thus they were unpriced and hence the system would be necessarily inefficient.” Mises refined his argument in his 1922 publication “Socialism: An Economic and Sociological Analysis”. Hayek was profoundly impressed by Mises work in this area and set about developing Mises argument further in several essays in the 1930’s. In these essays Hayek claimed that “prices are not merely rates of exchange between goods but rather a mechanism for communicating information.” (Hayek, 1945). He argued that people have little knowledge of the world beyond their immediate surroundings and this is what forces them to be price takers, this is the crucial ingredient that makes the price system work. Again the economic profession did not appreciate Hayek’s criticisms. The planned society envisioned under socialism was not only supposed to be as efficient as capitalism but it promised to be fairer. Socialism was considered the wave of the future and Hayek’s apparent lose in the Keynes debate had lost him the credibility he needed to be recognised as the correct party on the Socialist calculation debate. Fortunately Hayek could not be discouraged and he continued to refine his argument for the liberal society. The problems of socialism that he had observed in Nazi Germany led him to write “The Road to Serfdom” in 1944. This publication won Hayek “monetary notoriety as a political thinker and marked the beginning of his later rise to leadership in the world wide libertarian movement.” (Blaug, 1988, p89).
“The Road to Serfdom” was a polemical defence of laissez-faire. In the book he argued that those who would rise to the top in a socialistic regime would be those who had a comparative advantage in exercising discretionary power and were willing to make unpleasant decisions. He claimed that socialism had a strong probability of leading towards totalitarianism because central planning could not be restricted to the economic sector and would eventually affect social life as well. Hayek wrote that “totalitarianism is not an historical accident that emerges solely because of poor choice of leaders under a socialist regime.” He showed that it is a logical outcome of the institutional order of socialist planning. He pointed out the need for market prices as conveyors of dispersed economic information. He also showed that attempts to replace or control the market lead to a knowledge problem.
In 1950 Hayek moved to the University of Chicago where he taught until 1962. While there he wrote “The Constitution of Liberty” in 1960. This work was “a major statement of modern liberalism, which shocked many readers by its effective criticism of inheritance taxation and high marginal rates of income taxation.” (Blaug, 1988, p89). In 1962 Hayek moved to Germany where he had obtained a position at the University of Freiberg. It was at this time that Hayek centred his efforts on examining the “spontaneous” ordering of economics and social activity. This idea encompassed the “belief that a harmonious, evolving order arises from the interaction of a decentralised, heterogeneous group of self seeking agents with limited knowledge.” This order, he claimed, “was not designed nor could be designed by a social planner, but merely emerged or evolved spontaneously from a seemingly complex network of interaction among agents with knowledge.” That is to say that the market is a spontaneous order, the result of human action, but not of human design. From this theory of spontaneous ordering Hayek had set about to reconstruct liberal social theory and to provide a vision of social cooperation among free individuals. Hayek continued his work on evolving order and linked it with political and legal theory. As a result of this work Hayek is commonly referred to as the founder of evolutionary economics.
Hayek spent the remainder of his years in Germany. In 1974 he received a Nobel Prize with Gunner Myrdal. Interest in Hayek and his work increased after the 1974 award and has kept on that track right up to the present day. Hayek lived long enough to see his rivals; socialists and Keynesians eventually defeated, and the re instatement of Classical Liberalism as a vibrant body of thought. The collapse of communism in Eastern Europe furthered the much deserved credibility of Friedrich von Hayek’s theories.
Hayek has been one of the most influential economists of the 20th century and is often referred to as the Adam smith of the 20th century. While speaking about Hayek, Milton Friedman the Noble Prize winner wrote; “I think the Adam Smith role was played in this circle (the late 20th century collapse of socialism in which the idea of free-markets succeeded first, and then special events catalysed a complete change of socio-political policy in countries around the world) by Friedrich von Hayek’s The Road to Serfdom.” Hayek can be credited with many distinguished accomplishments. He can be regarded as the key figure in the 20th century revival of liberalism. He played the lead role in the current tide change away from statism and back to liberalism which is regarded by many as a defining event of the 20th century.
Hayek contributed greatly to our present day understanding of macroeconomics. He emphasised the importance of prices. He explained that the price system reflects the imbalance of demand and supply, and it automatically steers resources to where they are most needed without the need for planners to discover, understand, and correct the imbalance. He showed that competition was a dynamic process in which people are constantly searching to discover the cheapest mix of resources to produce the most desired output. Hayek highlighted the advantages of markets over planning. He demonstrated that the planned economy rests on the unlikely assumption that everyone can agree what to produce unlike the market exchange which works because people value things differently. It is around these basic principles that Hayek based his theories which have earned him the renowned respect as one of the most masterful economists of his time.
Hayek’s reputation has gone through a remarkable cycle as has the popularity of his work. He has provided the present day world with many foundations on which to build our understanding of economics, he truly was the political economist that economics had not seen since Adam Smith.
References
Barry, N. P., 1981, Restating the Liberal Order: Hayek’s Philosophical Economics, Halsted Press.
Blaug, M. 1988, Great Economists Since Keynes, Harvester and Wheatshearf Press.
Herbert, R. F. & Ekelund, R. B., 1975, A History of Economic Theory and Method 3rd Ed, McGraw and Hill Publishing.
Shackleton J. R., & Locksley G. 1989, Twelve Contemporary Economists, Macmillan Press.